Rising mortgage interest rates have widened the gap between what it costs to buy a house versus renting one, according to BNZ chief economist Mike Jones.
In his latest Eco-Pulse publication, Jones has crunched the numbers on some hypothetical examples to test how the cost of buying compares with renting at the moment. These are the examples:
A home is purchased at the NZ median house price (currently 780k), financed with a 20% deposit and the remaining 80% as (interest only) debt. Interest costs are split equally across floating and 2-year fixed mortgage rates. To this we add maintenance, rates, and insurance costs at an assumed annual rate of 1.5% of the national median house price.
A new tenancy is entered into at the NZ median rent ($550 per week). To make it a fair comparison, the 20% house deposit deployed in the ‘buy’ example above is left earning interest in the bank. These (after-tax) interest returns partially offset total rent costs. For clarity we’ve split the effect out in the chart below (see the blue lines).
"In terms of operational costs – the cash leaving a bank account each week – the costs of servicing a new house purchase are currently much more expensive than equivalent rent costs," Jones said.
"On our numbers that’s always the case, but particularly so at the moment."
He said current cash ownership costs for a new purchase have increased to around 50% of average household incomes, compared to around 30% in 2020.
Rent costs, by comparison, have nudged up to an average 24% of household incomes, or 18% once interest earnings are added back in. Jones has made the assumption, for comparability, that renters park a 20% house deposit in the bank. "This makes the comparison fair but of course may not reflect reality."
Jones said the average expense associated with purchasing the median New Zealand home currently exceeds that of renting by just over $38,000 per year "according to our back-of-the-envelope numbers".
"That’s seemingly a large number to overcome. But if house prices were to rise by around 5% over the coming year, this shortfall would be entirely offset by a positive house price revaluation (admittedly a paper ‘gain’ rather than cash). In contrast, if house prices were to go in the other direction it would dramatically increase the shortfall," he said.
The divergence between buying versus renting is currently largest in Auckland (63% of income to service a new home vs. 24% of income to rent, or 16% when savings income is added in) but is "observable in all regions", according to Jones.
Average servicing costs remain lowest in Canterbury reflecting lower house prices.
"Overall, it’s clear that high interest rates have widened the wedge between the costs of renting vs. buying."
But despite all this, Jones said it’s not necessarily the case that renting will turn out to be the most cost-effective option over the long-term.
"First, inflation tends to deflate the value of borrowers’ debt over time, while rent payments tend to rise with inflation. But more importantly, what happens to house prices ends up being the key swing factor. And no one knows what’s going to happen there."
Jones has produced the graph below that plots the concept of the rate of house price inflation required to “break even” on the higher cash costs of buying.
He said that "consistent with our earlier analysis", it shows, on average, positive rates of house price appreciation are always required to break even.
However: "The current estimate of such is well above average and the highest since 2008."
As a sign-off Jones said that all the number crunching "is all well and good", but it risks missing the point for some.
"We’ve deliberately focused on the financials here and excluded all the big non-financial and circumstantial considerations involved in a buy/rent decision.
"It’s hard to put values in the spreadsheet for things like security of tenure and being able to hang your pictures up or renovate. When it comes down to it, these may well end up being the most important in the decision."
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